2006 (9) TMI 105 - HC - Income Tax

Interest paid to beneficiaries deposits can t be treated as loan in absence of agreement between the parties, the amount retained by trusts which is payable to beneficiaries would be treated as deposit not loan interest paid to beneficiaries not deductible from trust income

Summary

Issues:
1. Whether the interest paid to the beneficiaries is considered income of the Trust and if the Trust is entitled to a deduction of the same.

Analysis:
The Income Tax Appellate Tribunal referred a question regarding the treatment of interest paid to beneficiaries by a Trust for Assessment Years 1985-86 and 1986-87. The Trust claimed deduction for the interest paid to the beneficiaries, arguing it was treated as a loan since the beneficiaries did not withdraw the credited amount. However, the Assessing Officer, Commissioner of Income Tax (Appeals), and the Tribunal held that the interest paid could not be claimed as a deduction due to the absence of a loan transaction between the Trust and the beneficiaries. They emphasized that there was no privity of contract between the parties regarding borrowing, as beneficiaries had no control over their income until it was transferred to them absolutely.

The Trust contended that the Trust Deed allowed for loans, utilization of funds, and payment of interest, supporting their argument that the credited amount should be treated as a loan. The Trust Deed specified the distribution of income among beneficiaries, either in cash or through book entries. The Court noted the distinction between loans and deposits in commercial transactions, highlighting the necessity of a formal agreement and interaction between parties for a loan. The absence of a loan agreement between the Trust and beneficiaries led the Court to conclude that the credited amount remained a deposit and not a loan.

Referring to a previous judgment, the Court affirmed that a Trust is a separate legal entity from beneficiaries, and once money is payable to beneficiaries, it cannot be considered the Trust's property. The Court emphasized the lack of an agreement or direction from beneficiaries to treat the credited amount as a loan. Without a formal agreement specifying interest payment, the Court held that the interest paid to beneficiaries could not be claimed as a deduction and constituted income for the Trust. The Tribunal's decision was upheld, ruling in favor of the Revenue and disposing of the Reference with no costs incurred.